Couple tax questions

[KrazyHorse]

Putting money in a bank is a way of aggregating and transferring risk. That is not the same as "active investing" (by which I mean the purchase and sale of securities on a regular basis).

By the way, the government insurance of deposits is funded by the depositors themselves, through payments to the FDIC.

[Jon Miller]

But there is a different purpose. The idea is that that money is being held safe by the bank, the fact that the bank can then use that money to invest/etc is a separate issue. The money being held safe is the reason why the government insures it.

The purpose of bank accounts isn't investment.

The reason why banks are needed for this safety purpose is that it is safer for people to have money in banks, rather then have it sitting under their mattresses/etc.

And depositors don't pay more for how much they deposit?

I did think that active investing was not putting money in the bank. But apparently it is also not putting money in a mutual fund?

JM

[Jon Miller]

The reason why the interest rate for savings is so low, is because the banks don't need much money in them. This is because they can lend out far more money than is given to them.

It isn't like they are investing my money. They are serving two separate purposes, to lend out money to others and to hold save money of still others.

These are related a bit because at one time you couldn't lend based on assets.

If you required banks to only lend out the money that was stored in them, you would see the interest rate for savings accounts increase a lot, and banks wouldn't make nearly the profits they do now (also the rates for loans would also change).

JM

[KrazyHorse]

But there is a different purpose. The idea is that that money is being held safe by the bank, the fact that the bank can then use that money to invest/etc is a separate issue. The money being held safe is the reason why the government insures it.

???

No, the reason the government insures it is to prevent bank runs, which are a result of duration mismatch between demand deposits and fixed investments/loans.

The WHOLE REASON banks exist is to aggregate and transfer risk. They act as credit bridges between people who wish to have liquid, safe assets and people who want to borrow on a longer term with more risk FROM the bank.

The purpose of bank accounts isn't investment.

And what is the purpose of money market accounts? CDs? Coupon-bearing bonds?

The reason why banks are needed for this safety purpose is that it is safer for people to have money in banks, rather then have it sitting under their mattresses/etc.

No, banks are needed so that people's excess liquidity can be turned into investments.



BAC has 700 BILLION in deposits. That's a HUGE amount of money which could not be invested without a bank to aggregate it. THAT is the purpose of banks.

And depositors don't pay more for how much they deposit?

???

Of course they do. Banks pay a certain percentage of their insured deposits to the FDIC each year. This shows up as one of the reasons for the spread between the interest (if any) that banks pay on deposits relative to the yield that they earn on investments. The other spreads are due to risk and liquidity premia.

I did think that active investing was not putting money in the bank. But apparently it is also not putting money in a mutual fund?

Putting money in a mutual fund is a form of active investing (depending on the mutual fund; index funds are examples of non-active investing) because the mutual fund actively manages its portfolio to try and beat the market on behalf of its investors. It simply transfers the activity from the individual to the fund itself. This is why actively managed mutual funds charge much higher fees than index funds.

[KrazyHorse]

The reason why the interest rate for savings is so low, is because the banks don't need much money in them.

No, the reason it's low is that people tend to pay a lot for the liquidity and security that banks pay them.

This is because they can lend out far more money than is given to them.

NO.

It isn't like they are investing my money. They are serving two separate purposes, to lend out money to others and to hold save money of still others.

OF COURSE THEY ARE INVESTING YOUR MONEY! Whose money do you think they're investing?

These are related a bit because at one time you couldn't lend based on assets.

?

If you required banks to only lend out the money that was stored in them, you would see the interest rate for savings accounts increase a lot, and banks wouldn't make nearly the profits they do now (also the rates for loans would also change).

????

I have the feeling that you don't understand how fractional reserve banking works AT ALL.

[Ramo]

26 U.S.C. 1(h)(3)(B), (h)(11)(B).

The general rule was pounded into my head over two federal income tax classes and a corporate income tax. I may be a bit rusty on the material, but that one's right up there with "partnerships don't pay taxes" in terms of things one remembers . The sections above specify that net capital gains include qualified dividends, and describe the qualifications, respectively. The exception was carved out as part of the 2003 Jobs and Growth Tax Relief Reconciliation Act.

Trying to look up the law. I don't understand your notation here. Can you link to it?

What are the qualifications? How often does the "general rule" apply, and what's the rate associated with it?

[Jon Miller]

Ah, OK. I am clear then on what active versus passive is.

If you look at the index funds/etc, and the rate of return on them, and the interest rate given by banks/etc, it seems obvious to me that banks aren't investments but rather just holding areas for wealth that doesn't have somewhere else to go.

The banks then use that and make it go somewhere useful. However, the banks benefit from that, not the person who is holding their money in the bank.

I have over 4000$ in the bank. I get nothing from that, if I invested it in an index fund/etc I would. I don't put it in the index fund because I think I might need the money in the next few months and so leave it in a bank account. There are millions like me, many of them deciding to hold larger amounts than I in their bank accounts.

If they truly wanted to invest, they would do so. They aren't looking to invest, they (like me) are looking to hold their money somewhere safe for a while.

And the banks profit on that.

Anyone who is smart and looking to invest would never put their money in a savings account/etc. There are things that are basically just as sure, but give higher return rates. The issue is that those things aren't liquid assets, that is the reason people place money in the bank, so they can spend it tomorrow.

JM

[Solomwi]

Putting money in a bank is a way of aggregating and transferring risk. That is not the same as "active investing" (by which I mean the purchase and sale of securities on a regular basis).

By the way, the government insurance of deposits is funded by the depositors themselves, through payments to the FDIC.

In this context, it might be helpful to use "short-term" and "long-term" investing for that, rather than "active" and "passive," since the tax code also discourages passive investing, in the "silent partner" sense, relative to active investing, in the "involved in the management of the business" sense.

[Jon Miller]

No, the reason it's low is that people tend to pay a lot for the liquidity and security that banks pay them.

This is because they can lend out far more money than is given to them.

NO.

It isn't like they are investing my money. They are serving two separate purposes, to lend out money to others and to hold save money of still others.

OF COURSE THEY ARE INVESTING YOUR MONEY! Whose money do you think they're investing?

These are related a bit because at one time you couldn't lend based on assets.

?

If you required banks to only lend out the money that was stored in them, you would see the interest rate for savings accounts increase a lot, and banks wouldn't make nearly the profits they do now (also the rates for loans would also change).

????

I have the feeling that you don't understand how fractional reserve banking works AT ALL.

My understanding of leverage is that it allows someone with assets to take out a loan on those assets of excess worth than those assets. The banks use their deposits as assets to take out a loan which they then invest. Except I think that they don't have to take out a loan from another bank, that they can loan out against their own assets without involving other parties.

This is how a bank lends out far more money then they have in deposited in them.

JM

[Ramo]

Regarding capital gains/dividend taxes, this is one way to make the federal tax code significantly more progressive. Helps to balance out regressive state and local taxes. The net ends up being roughly a flat rate.

[KrazyHorse]

Basically, a bank operates on the following principle (simplified):

1) A bunch of people start a bank by purchasing equity. This forms the bank's core capital.

2) The bank advertises that it is, in fact, a bank

3) People deposit money in the bank. The amount of deposits that they invest is generally far larger than the bank's equity.

4) The bank invests out a large portion of the deposits (either as equity investments or loans/purchases of debt). It keeps some of the deposits to ensure liquidity, i.e. having enough money to give people when they ask for the cash in their account.

The bank pays a certain portion of its deposits to the FDIC every year for the insurance functions of that entity. This, along with other costs (commercial banking services, for example) are passed along to depositors in the form of lower interest rates and occasionally fees. Since deposits are demand accounts (you get your money as soon as you ask for it) and are riskless (fully insured with FDIC for all intents and purposes) and since the bank provides services on deposited funds, these funds generally offer low or no interest. Other deposits (CDs, for example) have lower liquidity and more risk, so they pay higher rates.

[Jon Miller]

In this context, it might be helpful to use "short-term" and "long-term" investing for that, rather than "active" and "passive," since the tax code also discourages passive investing, in the "silent partner" sense, relative to active investing, in the "involved in the management of the business" sense.

I would think that active investing in the 'involved in the management of the business' sense would be better. As then you are more directly involved and responsible for the bad decisions that your company makes (ala GM).

I mean, it is a cost on society to bail out GM/whoever. As such those who aren't actively involved in the decisions should be taxed more than those who aren't (on the theory that they aren't acting less responsible).

JM

[KrazyHorse]

In this context, it might be helpful to use "short-term" and "long-term" investing for that, rather than "active" and "passive," since the tax code also discourages passive investing, in the "silent partner" sense, relative to active investing, in the "involved in the management of the business" sense.

I'm thinking of the financial services terms "actively managed" and "passively managed"

[KrazyHorse]

My understanding of leverage is that it allows someone with assets to take out a loan on those assets of excess worth than those assets. The banks use their deposits as assets to take out a loan which they then invest. Except I think that they don't have to take out a loan from another bank, that they can loan out against their own assets without involving other parties.

???????????????

I have NO idea what you mean by this. How can they borrow money without another person being involved?

They are borrowing YOUR money and lending it to OTHER PEOPLE!

The idea of leverage is PRECISELY THIS.

[Jon Miller]

Basically, a bank operates on the following principle (simplified):

1) A bunch of people start a bank by purchasing equity. This forms the bank's core capital.

2) The bank advertises that it is, in fact, a bank

3) People deposit money in the bank. The amount of deposits that they invest is generally far larger than the bank's equity.

4) The bank invests out a large portion of the deposits (either as equity investments or loans/purchases of debt). It keeps some of the deposits to ensure liquidity, i.e. having enough money to give people when they ask for the cash in their account.

The bank pays a certain portion of its deposits to the FDIC every year for the insurance functions of that entity. This, along with other costs (commercial banking services, for example) are passed along to depositors in the form of lower interest rates and occasionally fees. Since deposits are demand accounts (you get your money as soon as you ask for it) and are riskless (fully insured with FDIC for all intents and purposes) and since the bank provides services on deposited funds, these funds generally offer low or no interest. Other deposits (CDs, for example) have lower liquidity and more risk, so they pay higher rates.

I was pretty certain that the bank loans out far more than it has on hand?

While you can express it in those terms, I Think you under emphasize the importance of liquidity for those who 'invest' in a bank.

I mean, you can use the same language to say that putting money under your matress is investing, it just has very high liquidity and slightly more risk then a bank account (it isn't insured). As such, it gives no interest.

People don't think of bank accounts as investnig, if they are looking to invest (get a return on their money) they put money in index funds, mutual funds, or CDs (things that give them a higher return).

The bank deposits are purely for liquidity reasons.

JM